Tuesday, December 21, 2004

Morgan Stanley Global Economic Forum

Given the cautionary perspective of Stephen Roach (Morgan Stanley) and other well-known economists, I am amazed that (a) implied vol is at a multi-year low and (b) long bond yields are so low. The latter can perhaps be explained by foreign central bank buying (and hedge funds plying the carry trade), but why are equity markets so sanguine about the coming year? Perhaps there are structural forces at work there as well? Will realized vol in the coming year be much higher than the market is currently predicting?

Roach: Finally, the US also needs a further weakening of the dollar, in my view. On a broad trade-weighted basis, the dollar’s real effective exchange rate is down about 15% from its early 2002 peak. This is a relatively small decline for a US with a current account deficit that is expected to rise to at least 6.5% of GDP over the next year. Back in the latter half of the 1980s, when the current account deficit peaked at 3.5%, the broad dollar index fell about 30% in real terms. In other words, America today has a current-account problem that is almost twice as bad as it was in the 1980s but a dollar that has fallen only about half as much. For that simple reason, alone, I would argue that the dollar has at least another 15% to go on the downside. While a weaker dollar will not alleviate America’s imbalances, it could well trigger the interest rate adjustments that might — especially since the current-account conundrum means that marginal changes in US rates are increasingly in the hands of America’s overseas creditors.

A spike in interest rates would definitely cause an equities crash. Roach should put his money where his mouth is and buy SP puts - or at least advise his clients to!

15 comments:

SHUANGHU, China - Yang Shan is in fourth grade and spends a few hours every day practicing her Chinese characters. Her script is neat and precise, and one day, instead of drills, she wrote letters to her parents and put them in the mail.

"How is your health?" she asked.

Shan, who is 10, then added a more pointed question: "What is happening with our family?"

Her parents had left in March. Their absence was not new in Shan's short life. Her father, Yang Heqing, has left four times for work. He is now in Beijing on a construction site. Her mother, Ran Heping, has left three times. She is in a different city as a factory worker.

Over the years, Shan's parents have returned to this remote village to bring money and reunite the family. They leave when the money runs out, as it did in March. Her father had medical debts and needed cash to see another doctor. Shan's school fees were due, and her grandparents also needed help.

"I think they are suffering in order to make my life better," Shan said of her parents. She added a familiar Chinese expression: "They are eating bitterness."

For the Yang family and millions of others in the Chinese countryside, the only way to survive as a family is to not live as one. Migrant workers like Shan's parents are the mules driving the country's stunning economic growth. And the money they send home has become essential for jobless rural China.

Yet even that money is no longer enough. Migrant wages have stagnated, education and health costs are rising, and the rural social safety net has collapsed - a crushing combination that is a major reason the income divide is widening so rapidly in China at the expense of the rural poor.

Migration also has meant that urban and rural children in China are growing up in starkly different worlds. In cities, upwardly mobile couples call their precious only child xiao taiyang, or "little sun," as in center of the universe. Children are indulged with clothes, toys and snacks: childhood obesity is a new urban ill.

In the countryside, the new vernacular phrase is liu shou, or "left behind" child. Millions of children like Shan are growing up without one or both parents. Villages often seem to be missing a generation. Grandparents work the fields and care for the children.

"We are a triangle, three people in three different places," said Mr. Yang, 36, the father. "The pain of missing one another is very difficult. All parents are the same in this world. All parents care about their children."

But Shan's parents, strapped with debt and obligation, are among the untold millions of people in rural China caught in a brutal cycle. Studies show that medical costs are the leading reason that people fall into poverty in China. Many city residents still have some health benefits, but peasants now fall under a pay-for-service system. Sickness can mean bankruptcy.

Mr. Yang went to Beijing in part to earn enough money for medical treatment. He was warned four years ago that he needed treatment for prostate problems, but he could not afford it. Now, his health has worsened on his construction job. He has missed days and is jeopardizing the pay he needs to see a doctor.

His wife, Ms. Ran, 33, wants to visit her daughter in February for the Lunar New Year, when migrant workers traditionally go home. But she said her factory in the city of Baoding will fine her $72 - roughly six weeks' pay - if she does not work straight through to July. Shan's school fees are due soon, and the family needs more money.

Shan has never left this village in mountainous central China, a few hours' drive from the Three Gorges along the Yangtze River. She is still a child, but she understands the pressures on her family and how her own future depends on getting an education. She grew worried when the school began asking for next semester's tuition.

The students in Shan's fourth grade class rose in unison as the teacher, Du Nengwei, tapped his pointer against his desk to start the lesson.

"Hello, teacher!" the children shouted dutifully in early December as Mr. Du, his eyes magnified through thick glasses, signaled for everyone to sit down. The children began shouting out memorization drills, and the sounds of rote drilling rose out of other classrooms, as noisy as squawking birds.

The village school, the focus of so much hope, is little changed from a century ago. The dirty, whitewashed building is made of mud brick and concrete. Shan's classroom has no heat or electricity. Light comes from two small windows.

Mr. Du said 8 of his 14 students had at least one parent who is a migrant worker. He knows that parents leave in order to pay tuition, about $50 a year for families that often live on less than $300 a year. School, even this school, is their only chance, he said.

"Some say they want to be a driver, a scientist or a teacher," Mr. Du said. "But nobody wants to go on being a farmer." Of Shan, he said, "she studies very hard and does well."

She usually ranks second or third in the class. At home, she studies as much as three hours a day. She said she wanted to advance to middle school, then high school, even college.

"The more schooling I have, the more knowledge I have," she said.

Her home is a mud-walled communal house built more than a century ago during the Qing Dynasty. Her grandparents sleep in one section, her aunt and younger cousin in another. Shan sleeps alone in two unheated rooms converted from a small barn. Her room is above the pen with the family's three pigs. Her parent's empty room is over the open pit that is the communal toilet.

"I'm not scared," she said. She has painted her colorless wooden shutter with the Chinese characters for "wealth" and "prosperity."

Her grandfather, Yang Xianglin, 72, said his three sons each contributed $150 a year to support the family. Two of the three are migrant workers; the third just returned home from a migrant job. But the money is not enough, so the grandfather must borrow from other relatives.

Shan knows she is poor, but does not seem to feel poverty's sharp sting. Asked if she has any toys, she brightened and showed off two tiny plastic figurines and a single silk flower. Her parents cannot afford more, though her mother stitched her a pink sweater.

"She misses them always," her grandfather said. "She keeps asking, when will her parents come home?"

Nearly every family in Shuanghu has had someone leave. Local wages are as low as $1 a day; a migrant can make $5 or more. A few fortunate families have built concrete homes with migrant money.

"We have more freedom now than when we had a communal life," said Lei Jinchen, 53, a neighbor whose two sons work at the same factory as Shan's mother. "We can now go out and find work. But we only have enough to feed ourselves. That's it."

Central government leaders often boast of new programs to benefit China's poorest villages. One national program called for farmers to hand over land for reforestation in exchange for annual payments. In 2002, Shan's grandfather surrendered two-thirds of an acre for promised payments of $65 a year. As yet, he and other farmers have received nothing.

Shuanghu was also designated for special antipoverty assistance, and about 50 families - including the Yangs - were named poverty households eligible to divide a $2,500 annual fund, or about $50 per family. But again, the Yangs and others have gotten nothing.

"Not many benefits get down to us," Mr. Lei said. "Local governments skim most of the money off."

So what remains is migrant work for the young and farming for the old. The mountainous landscape is impressive, but only narrow strips of land can be used for farming. In early December, Shan left for school one morning, and her grandparents walked up a rocky hillside toward their small plot.

The frost had lifted, and the grandmother, Hu Yangui, 65, squatted in the dirt and pulled turnips. She takes medicine for stomach ailments and arthritis, and the work tires her. She would let the turnips dry in the sun until afternoon, then feed them to the pigs beneath Shan's bedroom.

The grandfather grabbed a large bale of corn stalks to use as bedding for the pigs and loaded it onto his back. His arthritis sometimes keeps him from sleeping, but he said the corn was not heavy. In a lower field, a child's voice echoed against the hillsides. It was Shan's cousin, Yang Qinlin, 4. Her own father works several hours away, and she goes months without seeing him.

She was singing a melancholy poem about missing home that is memorized by schoolchildren across China:

On the worst nights, Yang Heqing is awakened by the cold. His bunkroom is in a warehouse district in southern Beijing that is home to tens of thousands of migrants. There is no heat for the subfreezing temperatures, and the bunks are planks of plywood attached to metal scaffolding.

The room, provided by the construction company, is like a map of poverty in China's rural interior. Mr. Yang and three others from around his village sleep on two rows of bunks. Farmers from central Sichuan Province are in a different section. Apple farmers from dusty Shaanxi Province sleep across the room beside a few men from destitute areas in Hubei Province.

There are 40 men in a room 30 feet long.

Asked how many of them have left wives and children at home, one man yelled, "All of us." Asked how much they are getting paid for working 12 hours a day, seven days a week for almost a year, they give an embarrassed answer.

"We don't know," another man admitted.

Mr. Yang, like the others, came to Beijing last March. He and his three friends learned from a cousin about a job working on a new government building. No firm promises were made on pay. Some men were told they could earn $500 or more for the year, nearly double the average income in the countryside. Others were told that workers from different provinces would be paid different wages.

No one knows. The crew bosses will pay them when the job is done in January. Until then, the company provides daily rice or noodles, and workers get $12 a month in spending money if they work at least 25 days. Mr. Yang said he had missed many workdays because of illness. He often gets only $6 in monthly spending money as a penalty.

"Sometimes I can feel the pain while I work," he said. "My chest hurts, and I have no energy."

Mr. Yang first became sick in 2000 after five months working for an oil company in the far western region of Xinjiang. He earned nearly $600, a bounty, but he would spend all of it on medicine and visits to doctors. The diagnosis was pneumonia and inflammation of his prostate. At a city hospital, a doctor recommended $1,200 in treatment, a price he could not pay. Mr. Yang returned home, and his wife feared he might have cancer.

Weakened, Mr. Yang stayed home for four years, and his wife left for work, alone, in May 2000. His father said he then became frustrated that his wife, not himself, was supporting the family. His daughter knew something was wrong.

"I always saw him buying medicine," Shan said. Her parents "don't know that I know," she added. "I'm afraid his sickness will become worse and worse."

In March, Mr. Yang felt he had to find work. He owed relatives nearly $300 for medical bills, and he could not make money at home. Sitting in his bunk in early December, he recalled the rush of excitement he felt arriving in Beijing to play some small role in building the country's booming capital.

His friend, Yang Xianglin, leaned over from the other bunk. He is a first-time migrant worker. Like many villagers, he thought working in Beijing would be exciting, even liberating. Now he wants to finish his job, get paid and never come back.

"It's not what we imagined," he said. "Migrant work is too hard. Even if the bosses are crooked, we have to obey them. I can't stand this. This isn't freedom."

Yang Heqing agreed, more from exhaustion than outrage. He had missed so much work that he finally borrowed money from his crew boss and visited a city hospital on Dec. 10. A doctor examined his prostate and suggested tests. The cost was $250; the boss had lent him $12.

Mr. Yang walked from the hospital to a nearby pharmacy and bought over-the-counter anti-inflammation pills. He said he was tempted to quit, take whatever pay the boss will give him and see the doctor again. But he also knows that he might not even get paid enough to return home.

Asked about his plans for his health and his family, he could only imagine as far as January, when his job will be done.

"My hope is for a few thousand yuan at the end of the year," he said. That is a few hundred dollars.

A Factory Mother

The outdoor market in Baoding is a patch of dirt where farmers have laid out mushrooms, tofu, cabbage and carrots. Cuts of meat are arranged on a flatbed, but Ran Heping cannot afford those. She and three relatives have just finished a 12-hour night shift at their factory and are making a weekly grocery run.

A handsome vendor haggles with Ms. Ran over the price of a head of cabbage. He is flirting and offers her a ride home. She laughs and walks away. She later says distance has destroyed the marriages of several workers at the factory.

Her factory in Baoding, about 90 minutes south of Beijing by train, makes metal balls for lawn games, to be exported to Europe and America, and smaller balls that Chinese manipulate with their hands as a form of traditional therapy.

It is dirty, difficult work, but the factory is a popular destination for migrants from Shuanghu because of word-of-mouth referrals. More than half the 70 employees are from around the village. The job is piecework, so workers get paid for each ball. During peak months, a worker casting metal or polishing can make more than $100. Usually, though, workers make less than $50.

Ms. Ran came here in 2000 when she left the village to support the family. Leaving her daughter worried Ms. Ran, but Shan was starting school and tuition was due. Ms. Ran also knew that her husband's illness gave her little choice.

"I knew we couldn't survive like this," she said. "I told Shan, 'I will go to work, and you be a good girl at home' "

She returned home nearly two years later. She brought almost $1,000, which went for medical bills, clothes, food, school fees, fertilizer and other farming costs. "When the money was gone, we needed more," she said. "I decided to go out again."

This time it was a shorter trip, from July 2002 until February 2003. She brought home only $210 after the factory deducted $72 for leaving without working a full year. She was furious and filed a complaint with the local labor bureau. Nothing happened.

The Yangs were together in the village for a year. But medical and school bills forced them apart again. When Mr. Yang left for Beijing last March, his wife left for a plastics factory. She later quit and tried to join her husband in Beijing.

"We are a family," her husband told her. "When we can, we should be together."

They were together for less than 10 days. Ms. Ran worked at a pastry factory but quit because the pay was so bad. She also said the cost of renting a room and living together in expensive Beijing would have erased the couple's savings.

She returned to Baoding and the metal ball factory in September. She is an inspector, an easier job that pays up to $40 a month. She is not lonely because several cousins work at the factory. They talk about their children or visit a local park together. There are days when she says being away in a big city can be exciting.

"There are no department stores where we are from," she said.

In November, she bought a bottle of shampoo for her long black hair. It was first time in her life she had ever bought shampoo. It cost $1.50.

These lighter moments are leavened by the dark. On the telephone, she pleads with her husband to see a doctor. "I said, 'When you get paid, spend all your wages to get better.' I said I would send my money home to take care of the family."

"But he doesn't really want treatment because it will cost so much," she said.

The grandparents called in December to ask for another $25 for Shan's tuition next year. Mrs. Ran wants to visit her daughter in February at New Year's. But her bosses insist she must work until July or again lose pay. She is angry but has decided she must stay. Her daughter does not know yet.

"I just hope that Heqing will recover and we can work together to put Yang Shan at least through high school," Ms. Ran said, when asked what she wanted for her future. "If his health doesn't improve, I'm worried we'll only be able to send her to middle school."

"It's a hard life," she added, "but we have no other choice."

An Unknown Future

Shan's grandparents say she almost never cries. She is happy playing with her friends and her cousins. Her parents both called on her birthday in July. She said it had made her happy.

In early December, she sat outside and practiced writing. The letters she had sent her parents months earlier never reached them; she did not have a reliable addresses.

Now, she started writing in a notebook.

"I want a ticket, a boat ticket and a bus ticket," she scribbled for a visiting photographer.

Where does she want to go?

"To see my parents," she answered. "I want to see my mom and dad. I think about them all the time."

For the moment, her earlier, darker image of their life had lifted. She wanted to join them. She wanted to be a migrant worker.

We are more than 2 years in a bull market that has involved most sectors of the market and most international markets. The market has seemed rather tame through this period, though there have been growing complaints that at least real estate and bonds are too expensive. Unlike any bear market I have found, we ended the bear market in 2002 with an S&P p/e ratio above 20. Earnings have been excellent, so as the market has risen the p/e ratio has come down to between 18 and 20. So, stocks too look pricey. What makes high asset prices suspect is the deteriorating quality of fiscal policy and a threatening fiscal perspective. Still, we are in a broad bull market and a calm one as well.

What I find amusing is that one of the MS economists - I think Jen, in London - lists three possible scenarios for next year, with odds of 20/20/60 percent. The first two scenarios would probably imply a big downward correction for equities, and the third at least a lot of volatility. If Jen is confident about his predictions, he should definitely "buy vol" right now.

I think next year's markets could very well be as benign as this year's. These macro forces can take a long time to manifest themselves, although when they do, look out!

I keep trying to argue away our macro problems, but they do not go away. What we do not know however is how long they can persist benignly. So, I lean to a conservative portfolio. But, a conservative portfolio has been just what was needed since this bull market began. What an odd period.

We can agree there are macro problems that will be tough to resolve gently, but we have no sense when the market will begin to recognize these problems. To date there is no such recognition. So, I prefer not to time this market but simply think conservatively, which has been just what was needed these last 2 years, and take profits now and then to increase a conservative stance. This market is so broadly positive and so clam, that we may continue on this course for longer than we have patience to time :)

Imagine roaming the world's largest ocean year after year alone, calling out with the regularity of a metronome, and hearing no response.

Such, apparently, is the situation faced by a solitary whale, species unknown, that has been tracked since 1992 in the North Pacific by a classified array of hydrophones used by the Navy to monitor enemy submarines.

The animal is called the 52 hertz whale because it makes a distinctive stream of sounds at around that basso profundo frequency, just above the lowest note on a tuba

Its sonic signature is clearly that of a whale, but nothing like the normal voice of the giant blue or the next biggest species, the fin, or any other whale for that matter, said Mary Ann Daher, a marine biologist at the Woods Hole Oceanographic Institution on Cape Cod.

Ms. Daher is part of a team built by Dr. William A. Watkins, a pioneer in marine mammal acoustics who died in September, that has spent years trying to eavesdrop on the largely hidden lives of whales.

In the current edition of the journal Deep-Sea Research, members of this team report that all signs are that the sounds come from a single animal, whose movements "appeared to be unrelated to the presence or movement of other whale species."

The 52 hertz whale may be maturing, since its voice has deepened slightly over time, Ms. Daher said. A gallery of sounds, including the call of 52 hertz, can be heard at www.pmel.noaa.gov/vents/acoustics/spectrograms.html.

Re: dollar-yuan and China development, I completely agree, the stakes are high for China and they will be very conservative in taking off the peg. I often read that they need 7% real GDP growth to keep social stability (absorb excess workers, etc.). I think the performance of the central bank's "dollar portfolio" is secondary for them. I did find a comment in a Times article (excerpt posted a week or two ago here) that the central bank regards their foreign reserves as a component of national wealth, so they won't be *entirely* cavalier about what becomes of $500B (or whatever it is now).

It sounds like I am arguing for an Asia-led Bretton Woods II, with the euro taking most of the punishment...

"I did find a comment in a Times article (excerpt posted a week or two ago here) that the [Chinese] central bank regards their foreign reserves as a component of national wealth, so they won't be *entirely* cavalier about what becomes of $500B (or whatever it is now)."

I remember and I too have been thinking about this, but have no conclusions.